Is Yankuang Energy Group (HKG:1171) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Yankuang Energy Group Company Limited (HKG:1171) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Yankuang Energy Group

What Is Yankuang Energy Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Yankuang Energy Group had CN¥85.9b of debt in June 2023, down from CN¥97.3b, one year before. However, it also had CN¥53.6b in cash, and so its net debt is CN¥32.3b.

How Healthy Is Yankuang Energy Group's Balance Sheet?

We can see from the most recent balance sheet that Yankuang Energy Group had liabilities of CN¥98.7b falling due within a year, and liabilities of CN¥89.7b due beyond that. Offsetting these obligations, it had cash of CN¥53.6b as well as receivables valued at CN¥26.6b due within 12 months. So its liabilities total CN¥108.2b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of CN¥121.8b, so it does suggest shareholders should keep an eye on Yankuang Energy Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Yankuang Energy Group has a low net debt to EBITDA ratio of only 0.55. And its EBIT covers its interest expense a whopping 14.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Yankuang Energy Group saw its EBIT decline by 7.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yankuang Energy Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Yankuang Energy Group produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

When it comes to the balance sheet, the standout positive for Yankuang Energy Group was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. Looking at all this data makes us feel a little cautious about Yankuang Energy Group's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Yankuang Energy Group you should be aware of, and 1 of them can't be ignored.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.